NPS: A good investment vehicle for retirement savings

While the recommendation of the parliamentary standing committee reviewing the Pension Fund Regulatory and Development Authority Bill, 2011, (PFRDA Bill, 2011) to cap the foreign direct investment limit to 26% has been the most discussed, other recommendations that evaluate the structure of the New Pension System (NPS), too, need some attention. Deepti Bhaskaran reports. Saving for the sunset years

While the recommendation of the parliamentary standing committee reviewing the Pension Fund Regulatory and Development Authority Bill, 2011, (PFRDA Bill, 2011) to cap the foreign direct investment limit to 26% has been the most discussed, other recommendations that evaluate the structure of the New Pension System (NPS), too, need some attention. These recommendations are aimed at making the NPS more investor-friendly.

Minimum guarantee

The standing committee has proposed a minimum guaranteed return on the contributions made by the members of the NPS. This is to ensure that the returns are not subject to the vagaries of the market and are on a par with other pension products that provide a defined benefit, such as the Employees Provident Fund Scheme (EPF).

For this purpose, the committee has proposed to peg the minimum rate of return on EPF’s rate of return. EPF gave 9.5% for 2010-11 due to a windfall gain; it had been giving 8.5% for about four previous years. EPF invests only in debt products and the rate of return once declared is guaranteed for the year.

However, NPS works differently. Under NPS, investors from the unorganised sector can choose among three fund options: equity (E), fixed-income instruments other than government securities (C) and government securities (G). However, you can invest only up to 50.0% of the funds in the equity option (see table).

The current structure of NPS allows an investor to enjoy market-linked returns while limiting equity exposure. Having a minimum guarantee on returns will change the fabric of NPS and will increase the burden on the government that promises to meet any shortfall if the fun d managers are not able to meet the minimum return criteria.

"The provision for a guaranteed return, which should not be less than the interest paid on EPF alters the basic structure of the NPS," said Dhirendra Swarup, chairman, Financial Planning Standards Board India, and former chairman, PFRDA. "It tantamounts to a partial return to a defined benefit pension against the original intention of a pure defined contribution scheme. The government will have to fill in the funding gap if the returns are below the minimum guaranteed amount. The funding gap in EPS runs into thousands of crores. In the final analysis, the burden will fall on the taxpayers."

Withdrawal facility

The other key recommendation, which takes NPS’ structure closer to that of EPF, is to allow partial withdrawals (see table). But it has suggested that these withdrawals be repayable. "Subscribers may be allowed to take a repayable advance from accounts, after 10-15 years of service," it said.

The withdrawal facility defeats the purpose of having a strict lock-in to help investors save for their sunset years. "Tier-I structure of NPS is meant strictly for accumulation," said Gautam Bhardwaj, director, Invest India Economic Foundation, a consultancy specialising in pension reforms. "However, it was realised that for government servants who moved to NPS, the withdrawal facility under the government provident fund was not there. In order to allow for partial withdrawals in case of emergencies, Tier-II of NPS was formulated. It is a flexible account that allows for withdrawals. So in the presence of Tier-II account any partial withdrawals from Tier-I account does not make sense."

Other recommendations

The committee has recommended that the pension regulator exercise stringent monitoring and review the guidelines issued to the fund managers periodically and strictly evaluate the performance with a view to ensure stability of returns to the subscribers.

While the PFRDA Bill may go in for further deliberations, NPS remains a good investment vehicle for retirement savings if you are a conservative or a medium risk investor.